Stephen Roach: Consumers need debt jubilee

The over-indebted American consumer will be hard pressed to simultaneously reduce debt and maintain levels of consumption that support economic growth. On CNBC today, Stephen Roach of Morgan Stanley says, we need “ways to forgive the excesses of mortgage, installment and revolving credit, as what was done in the 1930s, that will help consumers get through the pain of deleveraging sooner rather than later.”

There are four ways to reduce real debt burdens:

by paying down debts via accumulated savings.

by inflating away the value of money.

by reneging in part or full on the promise to repay by defaulting

by reneging in part on the promise to repay through debt forgiveness

Listening to Roach explain the conundrum of high unemployment and poor wage gains, juxtaposed with high debt, it is clear he recognizes there is zero chance that consumers will be able to support the kind of economic growth via deleveraging and accumulating savings that avoids a deflationary outcome. The macro backdrop for consumers is deflationary.

Central banks or fiscal agents might attempt to reduce the real burden of debt. Look at the UK where financial repression is the most advanced in the developed economies and the Bank of England has missed its inflation target time and again. The consumer there is in a world of pain. UK household finances are ‘worse than during height of recession’.

However, if we see another recession before the deleveraging is complete – as is my base case – deflation is going to be all around us, increasing the real burden of debt. In my view high levels of default or debt forgiveness are likely going forward in the US, Ireland, the UK, and Spain at a minimum.

The Roach video is below.

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Author: Edward HarrisonEdward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty five years of business experience. He has also been a regular economic and financial commentator in print and on television for the past decade. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College.

31 Comments

Hmm… let’s forget about forgiveness and go for the helicopter money the proper way. By that I mean, don’t give free money to banks so that they can give it (with interest) to the consumer or the government, give the money to the consumer directly, as a gift, by simply printing it.

They will use that money to either pay back some of their debt or they will simply spend it. Either way, the goal would be achieved.

You can give every single citizen (maybe even children) say $10k. Heck, you can start with a paltry $1000 and see if that does the trick (though it probably won’t) and “print more” if so needed.

The increased spending itself will hopefully drive inflation (hopefully including a good measure of wages increases) which will in the medium term help diminish the real value of debt.

Even the Chinese might agree to this, because it will greatly help the US consumer and boost their own exports.

The major danger is the potential development of bubbles as people and investors will probably flock to certain “safe” assets in an attempt to avoid the loss of value. But, that shouldn’t be much of a worry. We already have bubbles all over the place (gold, CHF, etc.), without any easily identifiable benefits to point at.

The problem with debt forgiveness is that those who didn’t go recklessly into debt would be the ones holding the short end of the stick. If you help everyone equally, there’s less of the thing called moral hazard.

Somehow, I think there would be greater political support for this sort of measure than for forcing the banks to take haircuts.

Asking ‘but what about the moral hazard’ ignores the alternative; a hopelessly stagnating economy, deflation, an awful job market, zero wage growth, and declining home values.

Are you really so committed to ‘fairness’ than you’d suffer all this yourself just to keep your neighbor from getting back on his feet?

More to the point, what’s ‘fair’ about making small-ball speculators suffer while institutional figures have their notes honored in full? After all these are guys who were much closer to the epicenter, much more reckless, and moving much much more money. If lenders were substantially at fault, why should they be entirely protected now? Doesn’t this create a different form of moral hazard?

What may make the necessary and entirely justified debt relief more palatable is a reversal of some of that bankruptcy law provisions that (not incidentally) accompanied the debt bubble. Specifically, undoing the 2005 law governing credit card debt (making it much harder to discharge via Chapter 11), and the exemptions from adverse rulings given to mortgage and student loan debt. Here, you’re not giving anything away so much as re-balancing a very out-of-kilter playing field. Indeed that’s exactly the kind of reform most sensible people would expect to result from a crisis like this.

If that doesn’t work, then more aggressive re-balancing may be called for. But I suspect that the simple restoration of proven safeguards would not only accelerate the recovery dramatically, it would also establish the kind of sober, prudent lending environment that’s been MIA for a decade.

I think this is exactly right. Although discussions on economic philosophies aimed at ameliorating the situation are both interesting and useful at the heart of this is a self serving banking system that let credit creation get out of control. All policies so far seem to have been aimed at making good a lot of ill considered private sector loans. As Mike Shedlock puts it what can’t be paid back won’t be paid back. It’s really become the elephant in the room, what I’d like to see is a full discussion of the ramifications of options 3 and 4.

Re the inflation in the UK, though this may help with government debt I don’t see how it helps with private debt – which is the big problem – without increasing wages, in fact it surely makes the situation worse.

In the ancient times they knew the problems of full credit systems, so partial debt forgiveness was somewhat included in sociocultural traits by the means of the state and religion, some way or an other.

But all this got lost in the transition of ancient times to middle ages, with the dominant morality framework totally changed, this got even worse with protestantism, so we have inherited a socio-economic structure product of bullion (not full virtual credit systems) and inadequate debtor-creditor relations.

Off course, forgiveness wouldn’t and shouldn’t go for free, but continuing the status quo based on the current frame is a no way. And somewhat, in a society where the majority is a debtor, won’t and can’t continue much longer.

Well if Roach says it, especially if deflation takes hold, then I have to pay attention and as one of the cautious who will suffer as a result, I’ll just have to try and hedge even more against it all somehow. But when you say “Central banks or fiscal agents might attempt to reduce the real burden of debt – look at the UK where financial repression is the most advanced in the developed economies and the Bank of England has missed its inflation target time and again”, please bear in mind that over 75% of UK public debt (such as state and public-sector pensions, index-linked gilts etc) is inflation-proofed, so it’s not so easy for the UK to reduce the real burden through the printing-press.

I am thinking more of consumers, Stevie, since it is the consumer which has experienced the largest balance sheet shock due to the crash in house prices.. If inflation is higher than expected then the real burden of consumer debt is inflated away. The problem, of course, is stagnant or negative real wage growth. That’s what I meant when I said the next recession will be one of default/forgiveness because you can’t inflate the consumer debt away unless you get wage growth.

I doubt that the level inflation proofing is that high. The public sector pensions are contributory and are being adjusted to a much lower definition of inflation CPI rather than RPI anyway. As for treasury most is conventional debt. Governments have been cautious with too much indexed debt, plus once bought it is usually held to maturity. In fact there is a shortage of such debt available.

OK. Lets ignore the moral hazard and think the process through. Everyone gets a cheque for 10K (say). The highly indebted will use it to pay off their debts, and the debt free will either spend it, or save it, probably (in these sort of times) more the latter than the former. So far so good. People have less debt, or more savings, or have bought stuff, boosting demand. Job done.

BUT. All the banks now have lots of cash, as the debtors have repaid them, and depositors have put their cheques in. What are they going to want to do? Lend it out at interest of course! So they’ll be offering cheap credit to everyone again. And all the people who’ve just got debt free will be encouraged to max out those cards again, or get a cheap mortgage. And a few years down the line we’ll be back right where we started.

If you instead prevent the banks from offering cheap credit, by statute, then the economy will be no better off, because the only thing fuelling Western economies for the last decade or more has been debt. More and more of it, year on year. If you forgive everyone’s debt, and prevent them from getting in that position again, you have to live within your means, and that means a lower level of overall demand, and a moribund economy, just like now.

And where would most of the money end up eventually? In China of course. All this demand created will fuel more imports from the Far East, thus perpetuating the massive imbalance between the West and the East.

All printing money and handing it out will do is push the problem of the massive structural imbalances down the road for a few more years, until it all comes back again, only worse. Its that problem that needs to be addressed, not some indulging Ben Bernanke’s wet dream of ‘solving’ the Great Depression by money printing.

Why not simultaneously increase the bank’s reserve requirements to a level that would force them to hold all that cash and not lend it out?

Admittedly, that would probably hit the smaller banks harder – so you could enable banks to apply for special exemptions in cases where their cash deposits haven’t increased substantially, despite a major influx of cash to the broad economy.

The point is that a large % of all the economic growth in Western economies in the last 2 decades has been driven by increased levels of debt, right through the economy. It has not been driven by improved productivity or technological innovation.

You can forgive all private debts if you like, but unless you want everyone to leverage themselves up again with more debt, you don’t boost the economy. That’s the problem. What we see as GDP growth has just been debt growth. We can all be rich, if we can find someone to lend us the money to make us look like we are, right up to the point when the money runs out.

Jim,
While the $10K drop might appear reckless, the end result, like you said is it all ends up in the banks M1 and M2, rather than excess reserves.
It’s true bankers will be looking for both depositors(because THEY have the money) and borrowers(because there will naturally be a need to borrow.
Any excess of deposits means the bank pays less to use it (should be zero on demand deposits), resulting in near-zero base interest rates.
The idea that people haven’t learned from their debt-saturation largesse seems unlikely.
And bankers are going to be squeezed by a shallow margin of interest rate spread.
Seems stabilizing to me.

Why don’t we start with the financial sector that invested (i.e., made bad loans)and LOST money FIRST taking the hit. Myabe bubbles are not harmless (and maybe Greenspan can’t see them, but I certainly could in my neighborhood)and cause significant and extreme damage.

Everything I have read is that other than the top (10%, 5% 2% 1% or 0.1% – take your pick)the vast majority of income for Americans has been stagnant or decreasing for going on 30 or 40 years. Coincident with that seems to be ever expanding credit – which I suspect is because it is easier politically to extend credit than raise real income (which nobody may actually know how to do).

It seems the policy is to save the captain of the Titannic, put him on another ship, and have him ram the iceberg again.

“Everything I have read is that other than the top (10%, 5% 2% 1% or 0.1% – take your pick)the vast majority of income for Americans has been stagnant or decreasing for going on 30 or 40 years.”

Well, that is the crux of the issue IMHO. We need to get the wages to their rightful levels – in quite a few countries. It is very likely that the debt binge was a manifestation of the wage problem, and not its cause. With wages repressed, a way to still facilitate GDP growth was to ensure that, in some way, a part of the profits would nevertheless end up in the hands of the consumers. That was consumer debt. The other solution, which is apparently seen in China, is overinvestment. Neither is sustainable.

So, the monetary solution, whichever it may be (helicopter for the corporations or for the individuals), needs to be complemented by policies encouraging a better negotiation position for the workers. A more immediate effect would have the shift of taxes some notches away from labor and towards capital and rent. This cannot be done just nationally or regionally as long as we have countries with active policies aimed at underselling their labor and cheapening their exports. Investment and export driven Asia is, I believe, another cause why wages in say US had to stagnate. Currency pegs hardly worked in the gold standard era, and today they’re nothing but manipulation for some purpose, which is a no-no with free trade.

The 70’s were an oil driven inflation problem and wages started to suffer due to the “malaise”. Then, starting with the 80s, the strong emergence of large parts of Asia is the cause of similar pressure on wages. I think we can see yet another timeline correlation starting around 2000, right after Asia learned some lessons.

In the US, but not just there, this was exacerbated by a policy move towards “laissez-faire” — deregulation, but I’m not entirely sure this wasn’t just another internal manifestation of the same outside pressure. Free trade exposed the US worker to competition from countries where – for lack of a better expression – harsh exploitation of the labor force was fair game.

Going for the extreme example, to prove a point: you simply can’t have fair, win-win, free trade, when a country uses slave labor, lax safety and pollution policies, and the other has attained modern living standards, political rights and imposes strict behavioral standards on economic agents.

With largely open access to technology, the slave owners will always be able to sell their stuff cheaper, while the others hardly have anybody to sell to (the slaves have few or no money to spend). Similarly, you can’t have some countries almost totally open to the world, while others retain strong control over important parts of their economies.

Instead of a world where the poor rise faster than the rich and close the gap, you have a world where the rich slow down in order to feed growth in the poor countries.

Accelerated globalization based on idealization (and some corporate interests no doubt) is a main source of these tensions, just as idealized and hurried European unification is the source of tensions there.

I do agree about the debts being the manifestation of the lack of wages growth. Though the route cause could be down to lowering of corporate taxation. It creates an incentive to boost profits through holding down wages. Globalisation could be a big factor. A solution would be to use the Citizens United ruling to tax corporations on the same basis as individuals. US citizens if I remember correctly are taxed on their worldwide income, at 35% . As such tax all corporations similarly. That way the trillions held offshore would lead to a huge tax windfall. Similarly tax capital gains at the highest marginal income tax rate then Warren Buffet would be taxed at the same rate as his secretary,

Basically an unwinding of thirty years of laissez faire regulations would help. Maybe protectionism would create demand for goods to be produced domestically. Though it will take a generation to restore the economy to a stable situation.

I have suggested that Greece and Ireland use odious debt provisions to wipe much of this debt out. It was simply criminal to force governments to bail out banks and to guarantee debts of banks. If these debts were to be declared odious then the holders of this debt would have to accept losses.

On an individual basis the same could be extended to high credit card debts and sub prime borrowers. This will free up incomes of those who benefit from such provisions.

Longer term governments need to clamp down on debt growth, though I suspect that many will avoid it because it is always the cheaper option for politicians. Though maybe linking their pay and benefits to a private debt level below 60% of GDP would lead to it being enforced. That would stop future bubbles.

From the beginning of the mortgage crisis there has been a failure to make a distinction between default and eviction. A lot of pain suffered by debtors and creditors could have been avoided, and still can, by offering delinquent mortagees an opportunity to enter into long term sale lease-backs, with backstop from the Government to support securitization of portfolios of the leased-back properties to recapitalize the banks and a potentially interesting security for savers. With a ten or 20 year option to buy at market price, you have a neat mortgage equivalent for the home-owner.

Stimulus per se is not going to turnaround employment in the critical construction sector. For that a Government jobs program will be necessary. A Goverment jobs program could be an opportunity to upgrade skill levels and promote entrepreneurial activity, if done right.

The “war on terror” could be replaced with mandatory civil defense training, so people would know what to do in an emergency.

If more purchasing power is desired, it would be appropriate to control medical cost inflation and prices of staples.

Stephen Roach is still of the opinion that the consumer is the motor of our economic system and we have to go back to the stupidity of consumerism as there is nothing else.
“The consumer-debt-based economy is doomed; good riddance. It was nothing more than an elaborate cargo cult based on marketable anxiety.”http://www.oftwominds.com/blogaug11/demise-of-consumer-8-11.html

Yes but there need to be new rules to stop this happening again. Like ending lender of last resort status. Let big banks fail. Unless there is moral hazard this will happen again. Arrest the entire board of any bank more than $100 billion that fails. Bankrupt all the directors before any government bailout can be applied. Make the hiding of bankers assets a criminal offence with minimum of 10 years and send their families to jail as well. Any transfers of bankers assets to spouse liable to seizure. So if a banker transfers his $100 million dollar home to a family member, just in case the bank fails treat them as accessories to bank fraud and bankrupt them as well. That way banks will shrink. Then if a bank fails it will not be systemic.

Meh. There is no “moral hazard” to worry about here. The entire premise of “moral hazard” was shitcanned with the Fed’s handing money hand over fist to the very fraudsters on Wall Street that caused the entire mess. It was compacted and burned with gasoline when the Fed, on the sly, fed 1.7 trillion dollars to Wall Street scum above and beyond the false front TARP. The entire government response to 2008 has been to ignore moral hazard, but only for the rich. Now it is time to play consistently and show the same concern for “moral hazard” for REAL people (those who WORK for a living) and flat-out forgive their debts.

Screw the idea of “moral hazard”. I wont buy into that crap at all, not since TARP and the secret Wall Street money hose was opened.

Banks were given a very important privilege to create money in the form of extending credit. This function requires diligence and careful consideration in regard to individual credit risks as well as to overall credit levels in the system. The financial crisis revealed that the banks were operating at too high a leverage and with too much risk. They were used to be saved by the Central Banks and certain that in times of difficulties the Central Banks were there to save them. They were like trained dogs and their master Greenspan or Bernanke would always be there to rescue them when unforeseen difficulties arose.

That may be true but that does not absolve them from their obligation to monitor overall debt levels in the system as well as being diligent in evaluating the debtors ability to not only service a debt but to be able to repay it over time. The banks clearly failed in this function that is the core function of banking but focused mainly on their compensation packages. The way these bankers enriched themselves in the process of driving the financial system into a wall was appalling and the average income earner was never able to comprehend their schemes but preferred to simply ignore them. Of course, the bankers explained their outrages income levels with free market principles of supply and demand, where the best simply could be hired with those kinds of benefits only. In hindsight those superior managers seem to have missed their mark considerably. The most interesting aspect of all of this is the fact that, after we have been more than 3 years in this financial crisis, the bankers continue to loot the system as if nothing ever happened.

True to form the Central Banks “saved” the financial system by saving those great financial institutions without whom the system would have collapsed, as was argued. Hardly were we out of the danger of collapse, the banks immediately went back to their old ways and were certain that this was a problem that would occur just once in a lifetime and now all was clear again. The real problem, however, had not been addressed but had simply been muddied.
In actuality, the losses produced of extending unsustainable levels of credit by the banks have been transferred to the public. Different ways were chosen to achieve this task in the form of free money for the banks, injection of government funds into some institutions, increase of basic money supply and so on.

The threat of system collapse would have been labelled blackmail if it would have occurred in another setting. However the bankers were able to influence the media, the legislators and regulators in their favour with all the financial resources available to them. Nobody was made to take any responsibility and no one was taken to account.

This represents a serious violation of the spirit of the Rule of Law that is the basis of western society. It seems that now the new rule is Might is Right. This changes many parameters in the compass of the social system within the western world. No one can be sure on what level and when one will be subjected to the financial abuse of those elites. Presently, the people in charge are trying to enhance financial repression of which one form is to keep interest rates below the level of inflation which affects mainly those that lived within their means over the past many years; another clear violation of the spirit of the Rule of Law as it transfers losses from bad investments to the innocent and decent part of the population. In addition, the increased level of government debt puts in doubt all those benefits promised by governments the world over.

It is interesting how the banks were able to confuse the public who was/is unable to grasp the actual situation. But considering the banker’s great financial resources, it seems not that much of a miracle to influence the media and the legislator and having politicians do their bidding. The question is what the heck can WE, THE PEOPLE do about it.

Usually, we could address such things on a political level as we are a democracy, right? But it seems that the system has been corrupted by all the money sloshing around and it is extremely difficult to find any electable person that will act against those powerful interests. In addition, it will take many years until sufficient numbers of persons with the new thinking and with integrity not to be corrupted by those lobbying efforts will be elected to office that will implement the changes needed. So, what should we do? Start a revolution?

Well, the blackmail used by the banks may be the only way to address the injustices that have occurred over the past few years. They showed us how to leverage one’s limited resources to achieve one’s goal. Therefore the following proposal to start the movement “SCARE 20.12.2012” should be seen in this context. The idea is that if by that time (20.12.2012) some serious injustices have not been removed from the system, people will start to withdraw their money from all financial institutions driving them into default. And it might work, because those who hesitate to support this threat may be left with no money as the banks will have to close down before all has been paid out.
Now, what demands are made if that scenario is to be avoided.

1. Bankers and past Bankers (all those working in the financial industry that earned in excess of $500k plus annually for more than 2 years during the past 15 years and this without any downside risk i.e. risk of financial losses, except the possibility of losing their job) have to be made personally accountable for their past activities and be removed from any such position that might directly or indirectly have influence on the money creation and lending aspects of the economy (this includes regulating agencies and politics) before 20.12.2012.

2. Present and past regulators have to be made personally accountable for their past activities and be removed from any such position that might directly or indirectly have influence on the money creation and lending aspects of the economy (this includes financial institutions and politics) before 20.12.2012.

3. Politicians that accept any financial support from institutions that are involved in the money creation and lending aspects of the economy will have to face a jail term of no less than 2 years without the possibility of parole.

When these 3 points are implemented before 20.12.2012, we the public will not destroy the financial system but support the way to find back to the RULE OF LAW and away from the idea of MIGHT IS RIGHT.

I think that the markets will beat you to it. There are still such huge potential losses out there that QE has not been successful in eliminating that another global financial crisis is imminent. Hopefully the public will not fall for “these banks are too important to be allowed to fail” line. In fact the anyone who utters it should be arrested as an accessory to fraud. It is very clear that our central bankers are clueless, especially Bernanke who clearly deduced the wrong conclusion from the Depression and its solutions.